The Supreme Court today ruled 8-0 in favor of the government in the long-running Quality Stores litigation, holding that severance payments are taxable FICA wages, even if they fall within the category of “supplemental unemployment compensation benefits” that are subject to income tax withholding under Code section 3402(o). See our prior coverage here. The Court’s opinion closely tracks the arguments made by the government in its brief.

The Court began by analyzing the definition of “wages” in the FICA statute, which it repeatedly characterizes as “broad.” That definition — “remuneration for employment” — appears to encompass the payments at issue because “common sense dictates that the employees receive the payments ‘for employment.'” Specifically, they are paid only to employees and often vary according to the function and seniority of the particular employee who is terminated. The Court buttressed this statutory interpretation by pointing both to other aspects of the statutory definition and to its history. In particular, the Court noted that Code section 3121(a)(13(A) exempts severance payments made because of “retirement for disability” and that exception would appear superfluous if “wages” did not generally encompass severance payments. The Court also observed that in 1950 Congress had repealed a statutory exception for “dismissal payments,” thus suggesting that severance payments are not meant to be excepted from FICA “wages.”

The Court then turned to responding to the taxpayer’s argument that a contrary inference must be drawn from the treatment of SUB payments in the income tax withholding statute — specifically, that section 3402(o) directs that income tax should be withheld from such payments “as if” they were wages, which indicates that they are not in fact “wages.” The Court found this provision “in all respects consistent with the proposition that at least some severance payments are wages,” citing to the Federal Circuit’s analysis of the textual issue in the CSX case. The Court did not reject out-of-hand the taxpayer’s reliance on the heading of section 3402(o), which refers to “certain payments other than wages,” but said that the heading “falls short of a declaration that all the payments listed in section 3402(o) are not wages.”

The Court then embarked on a detailed discussion of the regulatory background against which section 3402(o) was enacted in order to demonstrate why it should not be understood as reflecting a Congressional determination that SUB payments are not FICA “wages,” despite the contrary inference that might logically be drawn from its text standing alone. Briefly, the Court explained that Congress was solely focused on solving a withholding conundrum created by the regulatory treatment of SUB payments when SUB plans proliferated in the 1950s. The IRS sought to impose income tax on these payments, but it did not want to characterize them as “wages” because that would have caused state unemployment benefit payments to stop in some cases (because some states would not pay unemployment compensation to people receiving “wages”). As a result, some individuals were being hit with big tax bills at the end of the year. Congress wanted to implement withholding for such payments and crafted section 3402(o) broadly so as to cover a spectrum of payments without regard to whether they qualified as FICA “wages.” Accordingly, the Court concluded that section 3402(o) sheds no light on the definition of FICA “wages.”

The Court added that its approach is consistent with its 1981 decision in Rowan, which had been invoked to support the taxpayer’s position. The Court stated that the government’s position, not the taxpayer’s, best advanced “the major principle recognized in Rowan: that simplicity of administration and consistency of statutory interpretation instruct that the meaning of ‘wages’ should be in general the same for income-tax withholding and for FICA calculations.”

Finally, the Court stated that it would not address the validity of the IRS’s currently applicable revenue rulings that exempt from both income-tax withholding and FICA taxation severance payments that are tied to the receipt of state unemployment benefits. As discussed in our report on the oral argument in this case, the government was questioned repeatedly about these rulings because they are hard to square with the broad reading of the FICA “wages” definition advanced by the government here and now adopted by the Court. Those rulings are more generous to taxpayers than would appear to be required under the broad FICA definition. It remains to be seen whether the IRS will revoke those rulings and try to collect FICA taxes on such payments and, if they do, whether that will have an effect on the payment of state unemployment benefits. With the Court having refrained from invalidating, or even directly criticizing, those rulings, it is possible that the IRS will let sleeping dogs lie and continue to abide by the rulings.

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Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.